The Anti-Tax-Avoidance Directive (ATAD 1) was introduced last year, containing measures to prevent hybrid mismatches among EU Member States (MS). On 29 May 2017, the Council of the EU unanimously adopted an amendment to this directive, dubbed ATAD 2. The new directive addresses hybrid mismatches with third countries and adds cases not covered by ATAD 1, and expressly refers to the OECD's BEPS report (Action 2) as its source.
Member States have until 31 December 2019 to transpose ATAD 2's provisions, so that they're ready to be applied from 1 January 2020. Measures on reverse hybrids will need to be transposed before 31 December 2021 with effect from 1 January 2022.
ATAD 2 extends the scope of ATAD 1, which applied to situations of double deduction or deduction without inclusion resulting from the use of hybrid financial instruments or hybrid entities. The new directive now also includes situations involving permanent establishments, reverse hybrids, imported mismatches, hybrid transfers, and dual residence.
The private equity sector is particularly affected by ATAD 2's rules on payments made with a financial instrument involving a deduction without inclusion. The rule foresees that the EU payer will have to deny the deduction if the payment is not included within a reasonable period of time and if the mismatch outcome is attributable to differences in the characterisation of the instrument or the payment with it.
Luxembourg is a well-known holding location and, over the past two decades, has become the jurisdiction of choice for many private equity funds, due to the structuring and financing of acquisitions. It is, therefore, important to understand if and how ATAD 2 will have an impact on the typical tried-and-tested structures and instruments issued by Luxembourg companies for financing such acquisitions.
We have recently advised on a similar case in which the rules were found to have a limited impact, to the extent that the LP was a tax-exempt vehicle. Indeed, the preamble in ATAD 2 clearly states that a payment under a financial instrument should not, however, be treated as giving rise to a hybrid mismatch where the tax relief granted in the payee jurisdiction is solely due to the tax status of the payee or the fact that the instrument is held subject to the terms of a special regime.
On the other hand, the rule may have an impact in certain cases where the look-through approach of the BEPS 2 report is considered—for instance, for US investors in cases where the payment leads to a hybrid mismatch at their level.
Final comment
Given the complexity of ATAD 2 and the lack of detail provided so far, its implementation in each member state will need to be closely monitored.
Nevertheless, firms should start reviewing the potential impact of ATAD 2 on their existing structures, and whether some degree of restructuring might be necessary, immediately. That calls for a thorough understanding of the tax treatment of each investor and each entity and, in particular, the potential impact of relevant mismatch rules.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
